Monday, October 15, 2018

Sears and Kmart in Bankruptcy

The long-awaited Sears bankruptcy filing occurred overnight, and there are reasons to be skeptical. I am relying mainly on the AP story (“U.S. Sears files for bankruptcy protection amid plunging sales, massive debt” at CBC News) since it contains details not found in other early reports. These are the four main points going against Sears and Kmart:

  • History has not been kind to U.S. retailers that file for bankruptcy reorganization at the start of the Christmas shopping season. Those filing in January after a Christmas-season disaster have a shot at survival. A retailer that goes into bankruptcy before Christmas is too deep in debt to put merchandise on the shelves. The first example that comes to mind is Toys ‘R’ Us, a year ago, and of course, that retail chain is long gone.
  • The bankruptcy plan has only half of the financing needed to keep stores open through December. “More financing to be arranged later” translates to “We’re so broke we can’t even go bankrupt.”
  • The reorganization plan is, in so many words, “Stay the course.” Only 142 Sears and Kmart stores will close immediately, in two retail chains that may not have even one profitable store between them. Sears wants to continue the slow, cautious dismantling that has been the plan at Sears for the last ten years, resulting in a loss in almost every quarter. The CEO who was the architect of this downward spiral remains with the company. There is nothing to persuade creditors, investors, suppliers, or a bankruptcy judge that meaningful change is on the way.
  • Most of the assets are gone. Sears lists $6.9 billion in assets, compared to $11.3 billion in liabilities. In the past 11 years, Sears has sold its best store locations. The Canadian subsidiary went into bankruptcy and has already closed. The Land’s End and Craftsman names are gone, the Sears catalog a distant memory. The assets that remain will have to be scrutinized. Some may be less valuable than estimated. Many are surely encumbered in one way or another. There may not be enough assets available to provide the foundation for one retail chain on this scale, let alone two.

A retail bankruptcy can fall into liquidation from just one problem on this scale, and Sears has these four. The most likely outcome, then, is that the last Sears and Kmart stores close no later than April. There are reasons to imagine this happening sooner. First, a bankruptcy court could reasonably reject the bankruptcy plan. After all, “stay the course” is not a plan, and liquidation sales will bring in more money if they can be conducted during the Christmas shopping season. If the planned financing comes through and most stores stay open, that still leaves the bankrupt company out of cash in January. It would have to do something remarkable during the Christmas season to invite new investment that would allow it to continue, but no one goes into a Sears or Kmart store with the word “remarkable” on the tip of their tongue. So this is the big question: how many stores close in the next three months, and how many in the three or four months that follow?

Context and proportion are important. Most Sears and Kmart stores have closed already. At the company’s peak there were thousands of stores. If Sears and Kmart can keep a few hundred stores open for a short time beyond the end of 2018, until those stores close too, it is a footnote in the history of two once-proud retail names.

There could be three rounds of store closings in bankruptcy. There will be the initial list of 142 stores. This list is apparently not yet decided but would have to be announced in October. There could be a followup list of additional stores to close immediately after the after-Christmas sales. The size of this second list will be a sign of the balance of power between lenders and suppliers. Sears’ suppliers are better served if this second round of closings is larger; lenders are more likely to seek to avoid this second round entirely.

After the Christmas sales numbers are in, there would have to be a third list of stores closing because seasonal revenue was too low. This could be a short list if a miracle happens and Sears has a strong season. If the season disappoints, all the stores will close quickly.

Impacts

Workers. Sears employs close to 100,000 workers at its stores. The question workers face is, “Will my store close in December, January, or March?” If you work at the store, your hunch is probably as accurate as anyone’s detailed analysis.

Suppliers. Layoffs are likely at many Sears suppliers, and profit could be affected, especially in the current quarter.

The Kenmore brand. The Kenmore appliance brand will probably be sold at auction. The most likely buyer would be a large appliance manufacturer. Kenmore will be a vanity plate on appliances identical to those already sold under other brand names.

Malls. Sears was once one of the two anchor stores in about half of the malls in the United States. There are some malls, especially in the heartland, where it is the only anchor store still open. There could be dozens of malls that close next year after the Sears store closes.

Toys. Shoppers who needed toys for Christmas already had a chance to buy them at the Toys ‘R’ Us liquidation and will have a second chance as Kmart locations close. Popup toy stores this season will largely go unnoticed. Even next year might be too soon.

The Sears card. As Sears was taking its business apart, it sold off its credit card portfolio. Citibank will probably replace Sears cards with Mastercard cards, though with limited success.

Gift cards. I have never seen a Sears or Kmart gift card, but as always in a retail bankruptcy, if you are holding a gift card, spend it soon.

Sunday, July 22, 2018

The Long Arm of Unintended Consequences

It is no great trick to trace this summer’s rush to meet emissions testing deadlines (Reuters story: VW to temporarily park cars due to new emissions testing bottlenecks) back to 1976 and policy responses to oil price shocks and shortages. After four decades of a push to improve automotive efficiency, countered by a resistance to that push, the automobile industry still has not found a sensible balance.

Those with a deep knowledge of colonialism and its effect of the oil industry can add at least another 30 years to the backstory. When the urge to burn fossil fuels efficiently surfaced in the 1970s, it was a reaction to decades of artificially low prices for fossil fuels. That in turn was possible because the oil and automotive industries and the mining tycoons before them had been leaning on geopolitical muscle to transfer and obscure most of the costs of obtaining and burning fossil fuels. Mine owners and automakers just wanted a smoother path to profit. The parking lots full of untested cars in the summer of 2018 are the unintended consequence of compromises made in haste in the 1860s and 1960s.

My point here is not to explore the details of this particular saga, but to count the years. When things get this far out of whack, it can take a lifetime to get things back into a semblance of balance, a second lifetime to reach an effective functional balance. Just taking the example of gratuitous inefficiencies built into cars, there is little hope that this problem can be fully solved before 2050. After all, designs being drawn up this year will result in cars that are still being driven in 2050.

The time scale is the same as that of finding peace after a war, and it is no accident that political leaders used phrases like “moral equivalent of war,” “war on poverty,” and “culture war” half a lifetime ago to describe imbalances that we are still trying to fix today. If war is hell, a culture war means a culture that embodies the energies of hell. It does not matter whether you think of war or hell — the answer to either is peace. Peace comes about by solving the lingering consequences of the past on the level of one person, one car, one building, and one street.

Chances to solve the problems of past “wars” come up often, and they can be surprisingly mundane. In my life, I think of replacing my low-efficiency refrigerator five years ago or throwing away my NFL team apparel last spring. Don’t underestimate the effect on the future, including your own future, when you can put some form of “war” behind you once and for all.

Tuesday, June 19, 2018

Cigarette Decline Continues

U.S. cigarette use continues its long-term decline, though it can hardly be described as low. The New York Post headline for an AP story is “Smoking in the US is at an all-time low,” though the current 14 percent rate is still a fourth of the rate seen at the all-time high a lifetime ago. There continue to be worries about e-cigarettes and vaping, though it seems those are fading fads now after word of health consequences got out.

Cigarette smoking is declining for two main reasons: a smaller advertising presence and the early death of regular smokers. Tobacco companies are acknowledging that their products are deadly for the first time this week after the companies lost a 2006 racketeering case. The court in that case found that the companies got together to spread false information the dangers of cigarettes. The new court-ordered corrective statements still understate the dangers of cigarette smoking, since they are based only on the information tobacco companies had in 2006. They do not mention, for example, the more recent research implicating exposure to cigarette smoke in cases of sudden death from heart attack.

Other cultural trends are working against cigarettes. Cigarettes are part of a cluster of products and activities that might be seen as the gritty side of 20th-century culture. This cluster also includes beer, soda, coffee, smoked meat, narcotics, boxing, football, golf, sports television, secret societies, men-only lounges, motorcycles, pickup trucks, detective novels, and more — nearly all now in long-term decline as popular culture moves in another direction.

Friday, June 15, 2018

Is IHOP Still in Business?

A consumer brand’s social media efforts are usually directed toward sharpening and humanizing the brand. It is instructive, then, to look at the recent “IHOb” campaign from IHOP, which took the exact opposite approach. It was designed from the beginning to confuse and sow doubt. For a day, the storied pancake restaurant chain was talking about nothing but its format change. The newly renamed IHOb had thrown away its name and its menus. The new smaller menu had little more than an array of international burgers.

There was no human touch in this announcement. It was all preprogrammed and done according to a formula, as if there was no one there at IHOP headquarters, like a radio format change done by machine while the entire on-air and office staff is escorted out. Even the IHOb Twitter replies intended to reassure worried customers that the chefs still knew how to make pancakes appeared to come from a bot.

Customers who saw the announcement were confused. As the change was repeated on Twitter and in the news, the stories ranged from “IHOP is shutting down” to “IHOP thinks it’s going to be the new McDonald’s.” Toward the end of the day IHOP officers tried to reclaim control of the narrative, but with limited success. The public statements that IHOP was not really changing its name came across as a panic move after the rebranding was seen as a failure, or even as an internal scuffle at IHOP headquarters with the outcome undecided. Now that the dust has settled and the story has faded, there probably isn’t anyone who can tell you what really happened at IHOP. No one knows.

This is bad for business. To take your family to IHOP now, you first have to persuade someone that the restaurant is still in business and still has a recognizable menu. If it turns out you’re wrong, you’ll have egg on your face while you walk everyone back to the car. It’s a risk — and is IHOP such a good restaurant that you’re willing to stick your neck out to take people there? In a town with more than one restaurant, the safer move is to go somewhere else.

The impression I am left with, after reading all the news I could find, is that IHOP is attempting a nostalgia angle leaning on the 1950s diner era, but without a budget for period furnishings. In other words, IHOP seems to be trying to take on the failed diner chain Denny’s. It doesn’t make any sense, but I can find no other story that explains the new menu items. I’ve seen photos so I believe the new menu items are real. It’s a move that might appeal to IHOP customers born before 1955, but those who are younger must be forgiven if they feel slighted. Why would a restaurant take such a large step backward in food quality and selection? Has IHOP lost its collective mind? As the McDonald’s and Chipotle stories attest, the American public has not been kind in recent years to restaurant chains that try to turn back the cultural trend toward better food quality. IHOP was selling a menu of near-average food quality, but that is obviously not the case with its new menu. The attempt to move downmarket, apparently without a price cut to support it, could not possibly end well.

Any way you try to parse the story, the result is FUD, the fear, uncertainty, and doubt that may make potential customers hesitate. To be sure, there will be some IHOP regulars who respond with curiosity — “Let’s go over there and see for ourselves.” The broader public, though, no longer knows what IHOP stands for. If IHOP fails to recover from its name change and rebranding, marketing textbooks will record that it destroyed its brand in one day.

Monday, June 4, 2018

Starbucks Revisits Its Stores

Starbucks is trying to get itself out of the predicament it created by ceding control of its cafés. These first two adjustments may be regarded as baby steps, but they show that the company recognizes the problem it faces, if not necessarily the magnitude of the problem. That is a change from the company’s initial reaction to the incident in Philadelphia when a store manager had two customers arrested for no reason. Starbucks’ focus a month ago was on damage control for that one incident. The deep corporate denial about the systemic operational issues was intact at that point, but has softened as executives have taken a closer look.

First company headquarters in Seattle issued a policy change. After a year of official and unofficial experiments with a more aggressive approach to customers, the company seemed to recognize that it might be scaring many its loyal customers away from its cafés. In a change of heart Starbucks said that it would not forcibly remove customers or guests except in unusual circumstances. The policy makes a sincere, if tentative, attempt at writing down what those circumstances might be. As an example, if a customer falls asleep in the café, employees will attempt to wake and speak to the customer. Calling the police will no longer be an option as an initial response.

The things that were not said were just as important in the announcement from Starbucks two weeks ago. After two decades of telling store managers that the company does not know how to run a café, so that the store managers will have to figure it out for themselves, the company is taking the first steps toward reining in the excesses of the store managers it turned loose on its stores. This move is long overdue. It is an incongruous position for the world’s largest café operator to take the position that it has little advice to offer on how to run a café. Starbucks as a company should be the expert in this, certainly more so than the store managers it hires. This policy change reflects that intention. Starbucks has high turnover in its store manager positions, on the order of 50 percent per year, and most new store managers have no previous café, restaurant, retail, or hospitality experience, so the lack of operational guidance creates unnecessary stress for managers and customers alike at nearly every Starbucks location. No one expects a rush of manager firings to follow, but the explicitly stated policy tells all levels of management that store managers can no longer do whatever they please as long as their stores are eventually profitable.

Then Starbucks held its much-publicized racial sensitivity training. It was not the full day of training that some of the company statements had implied, but a half day at most locations. In other respects, though, it was a bigger initiative than one might expect from any corporate training program. This was not canned training put together at headquarters but was guided by outside experts. The training curriculum and materials were not stuck in the formulaic thinking that rules any corporate headquarters. Workers told me of meaningful discussion questions and exercises that led them to see everyday situations from a broad range of points of view.

This was also a highly visible exercise, as stores had to close halfway through the day, something customers have never seen before except in emergency situations such as severe weather or utility failures. Customer reaction was more positive than negative, with a few customers making a point of visiting the stores the next morning to show their support.

It is not enough. In most matters, Starbucks is still telling its store managers to make it up as they go along. For example, stores still run out of essential supplies as early as two hours after opening. As an occasional Starbucks customer, I am reassured enough that I would enter a Starbucks location again if I had a reason to, but I still hope I don’t have to — at least not yet, not until Starbucks has time to take the next steps to get its stores under control.

Monday, April 23, 2018

“Fire Your Customer” Reaches Consumer Retail, With Disastrous Results

Two racial profiling incidents, days apart. A Starbucks manager in Philadelphia called the police on two customers almost as soon as they walked in the door. The police arrived quickly and arrested the two for trespassing. The Starbucks CEO had to fly in from Seattle to sort out the situation. The charges were dropped, the manager, removed from duty but not fired. Three LA Fitness employees in Secaucus, New Jersey, called the police on a member and guest, again claiming trespassing. The police arrived but found no reason to arrest the two. The staff nevertheless ejected the two customers, telling the member he was banned from the club for life. Again executives had to sort the matter out. The three employees were fired, the member, reinstated.

What happened? Activists and executives alike concluded that these were simple cases of racial profiling. All four of the customers accused of trespassing were black. Staffers singled them out for hostile treatment because of their race. Blinded by racial prejudice, staff members looked at perfectly ordinary customers and saw them as a menace.

No doubt that is accurate, but there is more to it than that. No one would claim that either Starbucks or LA Fitness can succeed based only on its white customers. Executives and store staff would agree that the store’s success depends on having as many customers as possible — and even filling the store with customers is no guarantee of success. So where did this idea of having customers arrested come from? Furthermore, it is not just the nonwhite customers who are shaken up by seeing these events unfold.

Starbucks and the Syms Incident

Personally, I am particularly troubled by the Starbucks arrests, and it is not just because I saw them on video. The timeline is more troubling than the video. A Starbucks manager glanced at two customers and decided instantly that they were troublemakers, dangerous enough that the police would have to be called to remove them. I’ve had that experience — when people in a position of authority look at me and decide at a glance I am a troublemaker. When I was in school, I was a model student, but there were teachers who hated me instantly and forever, and earning straight A’s didn’t change their minds about me. I expect this, though of course it is not as frequent today as it was when I was younger. I am a rock musician and look like it. There are millions of people in America, surely more than 1 in 100, who would like to see all rock musicians and their fans locked up. It is a matter of religious faith for most of them. They will never change their minds. So how many of them are Starbucks store managers? Is it safe for me to go back into a newly aggressive Starbucks? The company hasn’t breathed a word of reassurance, so it remains an open question, and in the meantime, I haven’t been to a Starbucks.

How long before I go back to Starbucks? I am reminded of my experience at Syms, a clothing discounter. I always liked the idea of discounts so at one time it was my favorite clothing store. I must have spent thousands of dollars there. Then one day a sales representative hounded me out of the store. I think he must have taken me for a shoplifter based on my appearance and the fact that I was shopping for clothing for people other than myself. I was shaken to see how I had been profiled and targeted. I left the store quickly. At the time I told myself it was no big deal. Five years went by before I noticed that I had never gone back. A few years after that, I heard that Syms had failed and was going out of business. I went to the store one last time to see what I could buy at the liquidation sale, but my local store had already closed.

I was not the customer targeted in Starbucks’ new policy taking a more aggressive approach to its customers, but I so easily could have been. And while Starbucks is disavowing the racism behind the Philadelphia arrests, it is standing by its policies in all other respects. Is it safe for people like me to go back into Starbucks? I am not sure it is. One thing is certain. Starbucks is not the same company that it was a year or two ago.

Syms had multiple problems. Toward the end, its buyers were having trouble buying the well-designed clothing that the store was known for. Formal business clothing, surely its most profitable department, had just gone into a long-term decline. Still, treating its loyal customers with suspicion and driving many of them away could not have helped its prospects. Now Starbucks had decided to go down that same road. It won’t end well for Starbucks either, as I will eventually explain.

Customer Value

Both the Starbucks arrests and the LA Fitness police call have the hallmarks of a fire-your-customer event gone badly wrong. Perhaps “gone badly wrong” is the wrong way of putting it. From a corporate perspective, any false police report that turns into a public relations fiasco has gone badly wrong. But these incidents were wrong even before the police were called. The decision to expel the customers was wrong from the start. The starkly different reactions of the two companies when the respective incidents came to light shows a real difference in strategy between them. But first, what does it mean to fire your customer?

“Fire your customer” arises from the relatively recent discovery that some customers are more valuable to a business than others. It is not easy, never a fully valid exercise, to quantify the profit a business draws from an individual customer. A business is the combined effort of serving all of its customers. It isn’t literally correct to slice up the business into different parts for different customers. Nevertheless, there are meaningful ways to approach this problem, and the results are conclusive and surprising. In the typical business, a small fraction of customers provide most of the profit. The typical customer is not profitable at all. This last conclusion can be debated endlessly. With small changes in assumptions, you can conclude that the common customer types are generating either a very small loss or a very small profit, but this difference doesn’t matter.

The essential conclusion you must come away with is that the typical customers are not keeping the company in business. This realization busts a myth that business had labored under for five centuries. This remains our cultural assumption about business even though we have known for a generation that it is false. We imagine a business with thousands of customers, each one bringing in a small amount of money. Combined, this is a lot of money, enough to keep the company in business. It’s a nice picture. It is simply not true. The customer that contributes in a meaningful way to the profitability of a business is the rare exception.

When quantitative marketing analysts (such as myself) consider the customer base of a business, one of the first and most important distinctions we make is an attempt to separate the high value customers, the ones we think contribute to profitability, from the low value customers, the ones who contribute little or nothing to the profitability of the business. This customer segmentation is never perfect, but it is rarely subtle. In formal business clothing, for example, the high value customer is one who buys suits two or three at a time, multiple times per year. The business will never make a healthy profit on the customer who buys one suit at a time, no matter how often.

In an accounting fantasy, you could make a business more profitable by taking away all the low value customers leaving the business with a much smaller base of high value customers. As far as I know, it is with this concept that the “fire your customer” idea was born. In the fantasy world, your business keeps the 5 percent of customers who provide 80 percent of the profit. You’re doing 5 percent of the work, but getting 80 percent of the reward. Sounds pretty good, right?

The Unprofitable Customer

“Fire your customer” is the rallying cry. In its most extreme form, the objective is to refuse to serve, or “fire,” the masses of customers who don’t directly add anything to your bottom line. In rare cases, this might work. Imagine a print shop with 10,000 customers. It studies its customer base and finds that almost all of its profit comes from 18 customers — customers it barely thinks about as it spends most of its time on its largest customers. The president goes to talk to these 18 customers one by one and they all seem to agree with the idea that the print shop could scale down drastically so it can devote more attention on their jobs. The print shop closes its doors and lays off most of its staff. The workers who remain are doing work only for these remaining 18 customers. The business might even become more profitable than before as it finds ways to expand on the work it does for its 18 private customers. On the other hand, as far as the world is concerned, it is almost the same as shutting the business down. The doors are locked, and the print shop is no longer talking to the public. Most of the workers have lost their jobs. Their customers, other than the few private customers that remain, have lost a supplier. It might be the best outcome for the workers and customers who remain, and perhaps those gains outweigh the losses. But it’s still a drastic change, and that points to why the fire-your-customer strategy doesn’t work for very many businesses.

Fire your customer doesn’t work because after you’re done, the business you started out with no longer exists. To see this in stark relief, imagine that a restaurant refuses reservations from 90 percent of its customers out so it can only serve the few dozen customers who order the high-priced entrees and leave large tips. In an emergency, if the kitchen has almost run out of food, this might make sense, but it won’t work as an ongoing strategy. Do the few high-value customers want to eat in an empty dining room? No. They come to the restaurant not just for the food, but for the atmosphere. Without the customers, the atmosphere is gone. In the meantime, how can the restaurant ever bring in new customers if it is refusing reservations from people it does not know? Will there be enough qualified referrals from the existing customers to keep the restaurant in business? Probably not.

There are other ways that firing your unprofitable customers just doesn’t work. Knowledge@Wharton points out that a business with only profitable customers is especially vulnerable to poaching. That is, competitors will do anything they can to take away the customers of such a business, knowing that any such customer is likely to be profitable. Researchers think this may be the main reason why no fire-your-customers approach, no matter how well planned, ever seems to make a business more profitable in practice.

It is impossible to guess when an “unprofitable” customer may suddenly become important. A business may need a large number of customers to have the reputation that it takes to bring in new profitable customers. An unprofitable customer turns into a profitable customer at random times that a business can’t possibly predict.

Restaurant chain Denny’s tried the fire-your-customer strategy on the largest scale of any business I know of, and the attempt not only failed, but it ruined the company’s reputation and effectively drove it out of business. Denny’s decided its best customers were a certain demographic segment, never mind what that segment was, and it deliberately mistreated all customers who didn’t fit that profile. I can vouch for that because I was one of the customers who was mistreated. Items I ordered weren’t delivered to the table. The bowl of chili was hot on the outside but still icy in the middle. Denny’s was trying to get rid of me. The reason I am convinced of this is that these incidents never happened when I was accompanied by a member of their preferred demographic — on those occasions I was treated well. Of course, we have heard stories from Denny’s that were much worse than anything I experienced myself.

It is easy to see how this strategy backfired. Denny’s made a negative impression on an enormous number of people, literally more than half of its potential customers. Many of the people who they drove out were acquaintances and family members of the demographic they were trying to reach. Indirectly, their preferred customer group got a negative impression too, or they had to go elsewhere because they were dining with a group. In the end, the publicity was so bad that even people who had never heard a personal account of mistreatment at Denny’s decided they were safer to stay away. A brand doesn’t recover from that kind of negative publicity.

Fire Your Customer

If fire your customer doesn’t work as a way to reduce the number of low-value customers, then what is it good for? Marketing experts agree you can’t “fire” a large number of customers, so the strategy has to be reserved for customers who represent a real problem. These might be the customers who are never happy, no matter how good the service is. There are customers who are simply bad for employee morale. Some customers clash a business’s values and principles. Others are constantly trying to take advantage of you in some way or have shown that they can’t be trusted. These are the customers you fire. But if you are firing more than a few customers, it’s not your customers. If that happens, there is something that is fundamentally wrong with the business or the way it is presented.

A classic example of a failure here is Sprint, which decided at one point to cancel the mobile phone contracts of all customers who had made multiple customer service calls per month. The accounting looked sound: these were customers who cost more in call-center time than the company could possibly cover with the monthly subscription fees. Yet it was all a big mistake. The customers Sprint fired were not voluntarily calling Sprint customer service so often. They were calling because the company continued to make operational errors on their accounts, so that their service was interrupted or they were billed incorrectly again and again. By firing these customers, Sprint missed the chance to focus in on and correct some of its worst operational failings — fixes it needed to make urgently because the errors were costing the company tens of millions of dollars a year in extra work. By blaming the customers instead of taking responsibility for its own operations, Sprint not only procrastinated on the improvements it needed to make, it also gave a very poor impression to a very large number of people and created a public relations problem larger in financial terms than the problem it thought it was solving.

Seth Godin explains the principles of “fire your customer” in the short post “The Customer is Always Right.” One of the key principles he and others mention is that you must do your best to make a good impression on the customer you are firing. If the person you are facing is your former customer, your reputation is still on the line. The is a principle Sprint failed to think of when it cut off close to a million customers without having taken time to look into the customers’ very real complaints. Needless to say, the strategy did not lead to the savings and customer growth Sprint had been planning on.

You can’t fire very many customers without savaging your company’s reputation, so it is a strategy you have to use sparingly and strategically. It’s not the answer for every unprofitable customer, only for a few problem customers. It has to be only a few. If it seems you are seeing bad customers everywhere you turn, those are not bad customers. That is just a bad business.

CRM and Consumer Retail

The concept of customer value comes from the relatively new field of customer relationship management, or CRM. Some marketing experts take a narrower view of the field and refer to customer value management, or CVM. The objective of either CRM or CVM is to know what a customer means to the company and manage the customer relationship accordingly. The first part, knowing what a customer means to a company, depends on analytics frameworks that are not yet fully mature at this point, though they can provide useful guidance. In the last three years retail customer analytics have advanced to the point where retail store managers and even retail workers can get a meaningful sense of customer value. The customer value concept is making its way into consumer retail, and for the first time the analytic measures are detailed enough that the customer value score is not just a shot in the dark.

If the concept of customer value is just now trickling into in-store retail operations, it is arriving without the customer-specific analytics that make it work. CRM assumes you know who the customer is so that you can look up that specific customer’s history. At this point, this is still easier to do online or on the phone than in-store. Nevertheless, store workers must be starting to hear how little profit potential there is in the average customer. This is a particularly difficult thing to hear if you are a store manager and held responsible for bringing in more customers and making your store profitable. It must be tempting to try to reduce the number of low-value customers while increasing the number of high-value customers, in spite of the marketing experts who say this doesn’t work.

One area where retailers could do a lot better is with loyalty programs such as the frequent-shopper cards you might have in your wallet. When you study loyalty programs, it is the rare exception that they reach out to high-value customers. Most of the time, a loyalty program is geared directly toward the low-value customers, encouraging them to stay with the retailer and giving them extra discounts as an incentive to stay even though the retailer is already losing money on them. Retailers need to look for ways to redesign loyalty programs so that they preferentially attract high-value customers. They shouldn’t be going to such lengths to retain low-value customers.

The principles of CRM and customer value are simple enough. It is important to retain high-value customers and impress low-value customers. If these ideas are applied correctly, they won’t do much harm even if you are often mistaken about what a customer’s value is.

But if the concept of customer value is applied badly, starting with a fire-your-customer approach to low-value customers and compounding the error with a series of mistaken assumptions about what a customer’s value is, I think it’s obvious that the result can be chaos. My guess is that this is what happened both at Starbucks and at LA Fitness. Two store managers mistakenly thought they saw a threat to their profitability, and they panicked. If it can happen to these two managers, it will happen again. The more data retail managers see that shows them how little profit their ordinary customers provide, the less generous they will feel toward those customers. The way it looks to me, this is just the beginning. Fire your customer has just barely reached the retail space, and it is already a disaster.

Rogue Store Managers

In both places the actions can be attributed to rogue store managers, and the respective companies have publicly taken that stance. It fits well enough that not many will question it. If your first thought on seeing a customer you don’t recognize, who is acting essentially the way you expect from a customer, is, “We’ve got to get rid of this pesky customer,” then you may not be fit to work in retail at all. This degree of hostility toward ordinary customers is a fireable offense all by itself in a retail establishment. Dialing 911 and making a false statement to the emergency dispatcher, and subsequently to the police, turns a fireable offense into probably a criminal offense. A company that faces the public can’t put up with either from a store manager.

The rogue manager story almost covers the LA Fitness incident. Part of the reason I say that is that it is obvious that the staff was acting against their company’s interests. A health club has high fixed costs and sells on a subscription basis. It needs a large number of customers. Outside of busy city centers there are no health clubs that really have enough customers. Everyone who has been around a health club for a few years knows this, but even if the manager did not, LA Fitness staff are well trained and would have been trained in the company’s business model. The last thing you can afford to do in this kind of business is to tell a paid subscriber who is doing nothing more than acting like a paying customer that he is banned for life. It is no wonder if the CEO was infuriated to hear it. Even if the subscriber was seen as a unregistered guest, a club manager would still have the responsibility to try to sell him a subscription. But it was the club manager who checked in the customer when he arrived at the club, so the manager knew or should have known from the start that this was a paying customer. Somehow the manager saw a problem customer. It is hard to explain as a matter of confusion, hard to escape the conclusion of racial profiling and a rogue strategy of excluding a demographic class of customers.

It is also clear that the Starbucks manager was knowingly departing from company policy, just knowing how quickly she called the police after the customers entered the store. You know for a fact that no one from the store had a meaningful conversation with the two customers because they were not in the store long enough for that to have happened. There is nothing in Starbucks policy that says a customer has to place an order within a certain number of seconds after arriving in a store. It that is a policy in that store, it is one that the local management made up in a departure from company policy.

Despite this, the rogue manager story doesn’t quite hold up in the Starbucks story. In contrast to LA Fitness, Starbucks store staff are virtually untrained, and that includes store managers and the managers they report to. Managers also get shockingly little corporate support. There isn’t a clear system in place for how to do the basics of store operation, such as ordering supplies. This is why Starbucks stores are constantly running out of essential supplies — cups, lids, milk, napkins, pastries. Store managers are pretty much on their own in figuring these things out. You have to get to the third level of management, a manager responsible for maybe 40 or 50 stores, before you reach someone who is reasonably well informed on the Starbucks way of doing things. The store managers are encouraged to find their own ways of making each store profitable. And store managers are held responsible for store profitability, so they are under pressure to find solutions that might skirt company policy or even run afoul of the law if that’s what it takes. In this sense, every Starbucks store manager is a rogue manager, and that is by design. So Starbucks as a company can hardly sidestep its culpability by shifting the blame to a rogue manager. Starbucks barely knows what goes on in its stores, and it doesn’t really want to know. As troubles mount, it will eventually have to start paying attention, but the lack of reaction to the Philadelphia arrests suggests that the company is not yet taking its problems seriously.

Starbucks’ More Aggressive Tone, and Why It Could End Badly

There is another, larger reason why Starbucks cannot blame the incident on one rogue manager. Starbucks has shifted its approach in the last half year in a way that suggests corporate management has bought into the flawed version of customer value theory and is trying to reduce the number of low-value customers it has in stores while increasing the number of high-value customers. This builds on Starbucks’ efforts of the four previous years in promoting its mobile ordering app, drive-through windows, and loyalty programs. Starbucks seems to be trying to boost its business among its most frequent customers while reducing the labor costs of serving them. It wants to see fewer of the new and casual customers who are the most labor-intensive customers to serve. It is trying to make customers a little less comfortable in its cafés. As far as I can tell, this last change in strategy is the reason Starbucks headquarters ordered the new locks on the restrooms at the store in Philadelphia where the customer arrests took place. Extrapolating, it looks like Starbucks intends to be little more than a drive-through five years from now. I have heard Starbucks managers say out loud that we might eventually see all chairs removed from the café so that customers have no place to sit down.

Obviously that would be a drastic change. Yet as marketing experts have advised, you don’t undertake a broad fire-your-customer strategy and still have the same business standing when you are done. Starbucks knows this. It employs marketing experts and understands marketing better than most businesses. The reason its recent changes have been made so quietly is that the company is trying to delay the inevitable loss of customers that it knows is coming.

But I believe Starbucks is making a mistake. There is a reason to believe that Starbucks’ fire-your-customer strategy will undercut the core of its business. To see this, think of the most profitable transaction a Starbucks location is likely to have on a given day. This could be a customer purchasing 10 quarts of coffee and 15 pastries for a business meeting. If the customer has called ahead so that the coffee is ready, the store can make an hour’s worth of profit in five minutes. Who wouldn’t want more customers like that?

But consider why the business-meeting customer is possible. A business orders from Starbucks to impress on meeting attendees that the company has spared no expense in preparing such an important meeting. It is possible to make this impression only if most of the people attending the meeting have experienced Starbucks before. Most commonly they do so by going into the store as individual customers before 9 a.m. and ordering a cup of coffee and one other item — the most typical Starbucks customer, but also just about the lowest-value customer transaction Starbucks can imagine. The high-value customer is possible only because of a much larger number of low-value customers. This is what almost all businesses find when they analyze customer value. If Starbucks is successful enough in driving out the low-value customers, so that ordinary office workers lose their connection to the chain, the high-value office-meeting customer will stop going there. There won’t be any point in getting Starbucks coffee for a meeting if no one attending the meeting knows what that means. Without the low-value customers, the high-value customers fall away too, perhaps not immediately, but with a lag of no more than a few years.

In a similar way, if Starbucks succeeds in making customers less comfortable, customers will no longer think of it as a place to hang out with friends for an hour or as the place to go for a low-key first date. But then, those same customers are less likely to think of Starbucks when they want something special. If you lose customers for one type of transaction, you lose them for the other type too. The end game for this strategy is that Starbucks is the go-to place for coffee addicts seeking high-quality coffee, and hardly anyone else. Yet my belief is that that customer base won’t stand up either.

Consider the history of Starbucks. Starting in the late 1980s, Starbucks rescued a coffee culture that seemed to be in terminal decline. It did this by promising high-quality coffee and a friendly, fun environment. Starbucks is already not much fun anymore, and now it is losing the friendly part too. Then take away the casual customers, and even the hardcore addicts will notice the difference. It will seem as if the life has been sucked out of the place. This is the inevitable result because hardcore addicts, even if addicted to a drug as mild as coffee, can never be very lively. Lively and addicted don’t naturally go together.

It also looks bad to be going to a place frequented only by addicts. If it comes to that, people will be embarrassed to admit that they are regular Starbucks customers. Beyond that, there is the risk of a cultural shift if coffee addicts someday notice how they are being played by the coffee industry — a nightmare scenario for Starbucks that becomes more plausible if its customer base is reduced to just one class of customers. Coffee is not really as addictive as that. Half of coffee addicts could give it up entirely in less than six months just out of spite or shame. As unlikely as it sounds today, this could happen if the coffee industry is no longer propped up by Starbucks’ reputation. Starbucks is playing with fire in liquidating its reputation.

Starbucks’ Bungled Response

Starbucks’ response to the Philadelphia arrests has done little to reassure its regular customers. Starbucks, I believe, is correct to focus on the problem of racial profiling and unconscious bias as a way of defusing a volatile situation. Promising a day of in-store training to its staff on this subject is a good step. However, the training being planned appears to fall short of what was promised, and Starbucks has not said a word about addressing its underlying problems.

The training. Closing the store for a full day of training? It sounds like a strong move, but I am told it will be only half a day of training. And what will the training cover? From what I am hearing so far, it will not be limited to avoiding racial bias. It will also, and perhaps primarily, cover the topic of how store employees should respond to protests. It also does not look good that Starbucks’ main emphasis in this regard is the steps workers can take to minimize property damage. There is a brief mention of customer safety, employee safety, and cooperating with police, but Starbucks’ biggest fear is the cost of replacing the windows that might be broken or cleaning any spray-paint from vandals. The emphasis on defending the premises is demoralizing to some Starbucks employees I have read accounts from. Is Starbucks responding to its racist gaffe by digging its heels in? Does the company expect to repeat this kind of mistake after the CEO said publicly that it wouldn’t? Is every Starbucks location expecting to see picketers?

So maybe the “day” of training will include a solid hour of racial bias training. That hardly seems enough, but it could do some good. But what of the other issues? This is the only major training initiative Starbucks has undertaken in at least five years. Will it start to train store managers on the Starbucks way, so that Starbucks culture is no longer just a nice idea that lives in Seattle? Will it start checking in on its stores in a meaningful way? Will it do anything to address the extremely high turnover among its store staff? Will it find a way to respond more quickly when store managers make major errors? In every case, the answer appears to be no.

Most of all, customers want to know what has changed and what to expect from Starbucks now, and the company so far is keeping us in suspense. As customers, we can see that there are some customers Starbucks wants to keep and other customers it no longer wants to have around, and it is clear enough that this distinction is not meant to be made on the basis of race, but beyond this, we are left guessing. Customers are not abandoning Starbucks yet, at least not in large numbers, but after another incident, and then another after that, almost every Starbucks customer will start to have second thoughts, similar to the way the most loyal Chipotle Mexican Grill customers acknowledge they are taking a calculated risk in eating there after that chain’s endless series of foodborne illnesses. Do I want a good cup of coffee? Starbucks customers will ask. Yes. Is it worth the risk? Well, maybe just this one time.

Customer Beware

The phrase caveat emptor is written in Latin because it refers to a particular problem in ancient Rome. Vendors would sell substandard merchandise to unsuspecting buyers. Setting aside that caution about the goods, the essential social contract between a public-facing vendor and the public has remained essentially intact for the entire time since, a period of at least 25 centuries. One side of the contract says that essentially anyone can go into a public-facing retail space and can take the actions that the place implies. The reason that LA Fitness and Starbucks calling the police on their respective customers is so shocking is that it breaks this social contract. When a powerful institution breaks a social contract, everyone pays attention because suddenly we don’t know what to expect from the world.

In this sense, the breach from LA Fitness is not so unsettling, and accordingly has not drawn so much attention, because the company took it all back in emphatic fashion. The breach from Starbucks is far more unsettling. Starbucks has disowned the arrests but not the changes in policy and approach that led to the arrests. Starbucks is still a place for people to hang out, but in a more limited fashion than you would traditionally expect from a coffee shop, and we don’t know what the new rules are. The social contract is normally assumed and so internalized that it is barely conscious, so when it is broken, people who were confident about their place in the world start to question everything, and that is starting to happen in response to the Starbucks arrests. This explains the enormous scale of the reaction to the incident at Starbucks. Two business men were arrested just for walking into Starbucks and sitting down? What is the world turning into?

It would not be so earth-shattering if these were just isolated incidents, but no one believes that. The Syms episode I related happened many years ago, and certain department stores have had a much worse reputation for a longer period of time for profiling and targeting their customers. What we are seeing now is just a new and more pointed version of the same thing. This kind of behavior from retailers could become more common for years to come as more retail managers gain progressively more data on how little profit the average customer is providing. Even though only a small fraction of stores will resort to throwing people out, I expect every single one of us will be profiled and expelled from a retail space at least once, not because we did something wrong, but just because someone thought we looked unprofitable or we did not look like a match for the customer profile that someone was hoping to see. When it happens to you, it will still be upsetting, but at least you can realize that you are not the first. Retail chains under financial pressure will tend to be the quickest to adopt the fire-your-customer approach, and doing so will hasten their decline, as the related profiling and targeting may have done in the case of Syms.

When the social contract starts to break, the results can be unpredictable. The retail space is struggling financially and struggling to adapt to the loss of anonymity for shoppers, long a fact of life online but now inching its way into stores. With retail already in turmoil, a generation of retail managers is facing what they now realize are mostly unprofitable customers, and too often, making snap decisions. A disaster is already upon us — just look at Starbucks and LA Fitness — and an upheaval is inevitable even if we cannot predict much of the outline of the changes ahead. For lifetimes we have taken for granted that we can go into a shop and buy what the shop is selling. When something as basic as that is no longer valid, we have little choice but to start questioning everything.

Friday, April 20, 2018

Trade War Adjustments in Sorghum

The U.S. sorghum crop is looking for new buyers after China imposed tariffs on the grain. The new tariffs are approximately two times the market value of the sorghum, so there might as well be a ban on U.S. sorghum in China.

Sorghum is considered a niche crop, but that does not mean it is small. Reuters identified 20 container ships carrying U.S. sorghum to China, en route at the time the new tariffs were announced. Five of these were seen to change course immediately when the new tariffs were announced.

One possible outcome is that all available Australian sorghum is sold to China, while U.S. sorghum is shipped to Australia to cover the shortfall. This potential change in trading pattern, resulting in greater costs which are reflected in higher prices in the importing country, is the kind of thing that makes economists skeptical of country-specific tariffs and quotas.

Sunday, April 8, 2018

FirstEnergy Bankruptcy Seeks Cost-Shifting for Coal and Nuclear Decommissioning

Among last week’s bankruptcies, there was another U.S. energy bankruptcy, but this one has more far-reaching implications than the ones that have come before. It is FirstEnergy’s coal and nuclear operations that are bankrupt. This is not surprising in itself. It has been ten years since coal and nuclear plants were cost-competitive on the U.S. grid. The most alarming thing about the FirstEnergy bankruptcy is the company’s request for an emergency subsidy from the U.S. Department of Energy. That request should be ignored. The Department of Energy has said in the past that the emergency subsidy provisions in federal law are meant for use to stabilize the grid following a regional disaster such as a hurricane or earthquake, and not as a routine way to compensate for investment mistakes. The request provides insight into the company’s intentions, though, which are to shift costs onto the public as much as the law will allow.

FirstEnergy investors lost billions of dollars buying archaic power plants that will ultimately be shut down at additional expense. It is better if those shutdowns do not happen all at once this year, but more gradually and at a more economically opportune time, but the shutdown nevertheless looms over the bankruptcy process. This appears to be a strategic bankruptcy intended to save investors the decommissioning costs of the nearly obsolete coal and nuclear plants. The cleanup has to happen to protect the public even if the investors and owners are unwilling or unable to pay for it. With the bankruptcy, most of the costs will be paid for by the public.

Coal and nuclear bankruptcies are likely to turn into a financial mess on a national scale within ten years. Absent an unexpected series of technological breakthroughs that make existing coal and nuclear plants less expensive to operate, all but a few of the best-designed coal and nuclear plants will be operating at a loss by 2027. The FirstEnergy bankruptcy case will set precedents around the question of how much of the costs of cleanup can be shifted to the public. Investors, obviously, would prefer to raid these utlities for as much money as they can and then pass the bulk of the decommissioning costs along to someone else. Unfortunately, it doesn’t appear that there is much that can be done under current law to stop this severely dysfunctional form of vulture capitalism.

Saturday, March 24, 2018

Why Facebook Is Losing Its Hold On Its Users

Facebook users were starting to tune out before the latest revelation, the news that it was Facebook itself that generated the core data used for micro-targeting U.S. voters on social media with fake news stories in the 2016 election. There was (and still is) no mass exodus of users deleting their accounts, and it is not that users were getting bored, but an increasing number of users were going out of their way to avoid opening the site and the app. The thinking, if I may attempt to paraphrase it, is something like, “I want to stay connected, but couldn’t I go for three weeks before checking in again? How about four weeks? Five weeks?”

This line of thinking is, obviously, a form of aversion. It is not the same thing I saw six years earlier when people were feeling hassled by propaganda directed their way by their psychopathic friends on Facebook, people who they either needed to mute or unfriend. No, the problem now is with Facebook itself. Facebook has become like that friend who isn’t really your friend anymore but is involved in a Bitcoin pyramid marketing scheme and is trying to feel out your level of interest in Bitcoin without being too obvious or owning up to any of it, except that they are being too obvious and you’re starting to feel creeped out talking to them. This is not what someone on Facebook is doing, this is what Facebook itself is starting to feel like to longtime users. It is trying just a little too hard to find out its users’ thoughts, opinions, histories, preferences. It is being a little too obvious about it.

Users feel a sense of apprehension on Facebook similar to the feeling of walking into a bar when you know your ex-spouse might be there and there are cameras in every corner. You want to be on your best behavior, say as little as possible, and get out as fast as possible before something bad happens. Yet as you leave, you wonder, did something bad happen? How would you know?

This kind of apprehension, the feeling that goes with an unsafe place, comes from an unconscious memory of bad experiences there, but it also reflects a sense of the roles in the place. Facebook users feel targeted. Or, to say it using another word, Facebook users feel preyed upon.

This is what they’re telling me. I have never been on Facebook myself except to assist users in deleting their accounts. I don’t believe any of my close friends are still particularly active on Facebook, so this is a summary of reports from less close friends, including some accounts that I have heard secondhand. But this is the consensus of what I am hearing. I think most Facebook users will acknowledge this view of Facebook, even if not all will agree.

One way of seeing how users feel about Facebook is hearing the reactions to the recent change in privacy policy having to do with face recognition. Facebook has long done its best to recognize everyone, registered user or not, who appears in a photograph posted on Facebook. Its facial recognition skills have only improved over the years. None of that is changing. But now Facebook is giving registered users the option to not have themselves automatically captioned in photos posted by strangers. Facebook still pretty well knows who every face is, and it will continue to identify you in photographs no matter what you do, but you can have it stop putting your name in the caption of a photograph. There are complaints that the world has come to this, of course, but some of the complaints are about the process of signing in to Facebook to turn off its automatic facial recognition photo captioning when your face is found in a photo. Facebook will turn the screws tighter just to get you to sign in so they can count you in their monthly active users. That is not a reaction a user would have to the action of a service that made them feel safe.

So Facebook is the wolf in the hills, users are trying to keep a safe distance, and then the news comes out about Facebook’s supposedly indirect involvement in the strategy of micro-targeting users for fake political news. There are several problems with this series of revelations, and the fact that Facebook threatened to sue a newspaper that wasn’t even the paper that broke the story is not even the worst of it. No, the worst is that there is no reason to believe Facebook’s assertion that it wasn’t directly involved and had no knowledge of the advertising-targeting algorithms. If that’s true, then why were Facebook engineers working onsite at the customer that was doing that analysis until the Monday after the weekend when the story broke? To a naive business news reader, it certainly seems like Facebook saw itself as a partner in a joint venture.

And it only gets worse. Users are downloading their data history from Facebook and are shocked at the extent of the data. It is not just a record of every click a user ever made on the Facebook site. There are records of actions on completely unrelated sites, dates and times of phone calls and text messages not made through the Facebook app or even with the app open, the names of every onetime Facebook friend. The text of messages that users thought they had sent privately to another Facebook user is in their permanent record. When people see this kind of thing, they can’t ever unsee it.

So in a few more days of this we will all understand that:

  1. Facebook is stalking its users with obsessive detail.
  2. Facebook is, at best, extremely careless about who has access to this data.
  3. This is not a safe arrangement for Facebook users.

This is why Facebook will not survive this data security debacle in its current form. A decade ago when the world was flocking to Facebook, it was for the sake of security. People were trying to get away from the security risks of the open Internet, particularly the overwhelming spam load of Internet email and the attack vectors built into innocent-looking web pages. Facebook offered a degree of protection from that.

By now, the shoe is on the other foot. Browsers have improved to the point where users can feel relatively protected from rogue web pages. Email services have done a reasonably good job at filtering out harmful messages, so that, believe it or not, there is actually less spam email than there was 10 years ago. People feel relatively confident about signing in to email these days.

No, now it is signing in to Facebook that gives people the jitters. In my opinion, the users who originally moved to Facebook for the sake of online security will not stay around now that Facebook is seen as possibly the largest privacy threat on the Internet.

The mere observation that Facebook is “losing its hold” on users contains the context that users feel like Facebook has its claws in them. Users feel like they are the object of Facebook rather than the agent of their Facebook experience. Facebook had already lost the hearts of users before they reached the question, “What will Facebook do to us next?”

Tens of thousands of users have deleted their accounts in the last five days. That’s not many, of course, though it is a number large enough to represent a measurable hit to Facebook revenue. The greater concern to Facebook, though, is the larger number of users who have gone silent. They still check in several times a month or at least several times a year, they read posts, but they are careful to avoid posting anything or liking anything. Maybe they’ll just post a holiday greeting in early December as a way to reassure relatives that they are still alive.

They’re still users, right? But for those with a sense of history, this is exactly how the old MySpace ended. It is not that users deleted their accounts in large numbers. They simply stopped posting. Once a site reaches the point where no one with any sense is posting new content, then there is nothing for users to read. They check in after three weeks and nothing has happened with any of their friends. “Maybe I don’t have to check in quite so often,” they think. Soon, they’re forgetting to check in for months at a time. By the time a user reaches this point, there is no possible way for the platform to win this user back. The user is no longer paying attention.

That was MySpace. But Facebook may already be far enough down that slippery slope that there is no realistic prospect of climbing back up.

Thursday, March 15, 2018

IHeartMedia bankruptcy

Another major bankruptcy filing today: IHeartMedia, the largest radio station operator, is in bankruptcy. This was expected and unavoidable as the company took on enormous debts to buy radio stations at the same time that radio is losing its reach. The interesting thing about this case is that it is not entirely clear that broadcasting licenses survive bankruptcy. Business leaders have always assumed so but this theory has not been thoroughly tested. The company says it will continue to operate normally and pay all its bills.

Trends are working against IHeartMedia in the long run, but for now it has cash flow and has some potential to cut costs through further automation.

The common element in the Toys ‘R’ Us and IHeartMedia bankruptcies is that both companies are swimming against the current when it comes to cultural trends. Radio is declining in mind share and cultural influence in much the same way that toys are.

Wednesday, March 14, 2018

Toys ‘R’ Us to Close All Stores

Word came this morning that the Toys ‘R’ Us U.K. subsidiary was unable to find a buyer and will close all stores within six weeks. From BBC News:

This announcement was expected after the subsidiary entered administration. Now that it has come to pass it carries the air of inevitability given the complexity of the Toys ‘R’ Us business arrangements and a wave of retail failures in Britain. Other reports from Britain indicate that layoffs at the stores started as soon as the announcement was made.

Meanwhile in the U.S. a bankruptcy liquidation court filing is expected early this evening. That plan would most likely lead to the closing of the remaining U.S. Toys ‘R’ Us stores and the web store.

There is a chance that stores in Canada could stay open. According to Bloomberg, toy manufacturer MGA (owner of Bratz) is trying to find investors to fund a bid for the Canadian operations, which are also in bankruptcy but have not faced quite the same level of operational stress as the U.S. and U.K. companies. Such a bid could also include a few U.S. stores and the web store. Time is short, though, and a credible bid might not be forthcoming if partners for the venture cannot be lined up by tonight.

Toys ‘R’ Us acknowledged the long odds it faces when it told employees late today that probably all U.S. stores, some 800, will close, and all employees, more than 30,000, will lose their jobs.

Update: Toys ‘R’ Us filed its petition to liquidate after midnight. The petition implies a quick liquidation of most stores. It suggests that there is a good chance that all Canadian stores remain open. USA Today:

Tuesday, March 13, 2018

Toys ‘R’ Us Stops Talking to Vendors

Sources associated with Toys ‘R’ Us suppliers told Bloomberg that payments from the company have stopped,

they can’t get anyone at Toys “R” Us to respond to questions [and the company] recently stopped negotiating settlements with vendors . . .

The Bloomberg story:

While nothing is definitive until it shows up in a bankruptcy court filing, this news is consistent with the recent narrative of a company on the verge of liquidation. There were rumors on Sunday that a liquidation plan would be filed on Monday, and that did not happen, but if a retailer is cutting off its suppliers, it cannot carry on for much longer than another week.

Update: Lauren Hirsch at CNBC writes of a Toys ‘R’ Us liquidation, “The retailer could file as soon as the end of Wednesday.”

Thursday, March 8, 2018

Toys ‘R’ Us Prepares for Liquidation

Toys ‘R’ Us is preparing to liquidate, according to sources who spoke to three Bloomberg reporters. The story posted this evening is “Toys ‘R’ Us Is Prepping to Liquidate Its U.S. Operations”:

Toys “R” Us Inc. is making preparations for a liquidation of its bankrupt U.S. operations after so far failing to find a buyer or reach a debt restructuring deal with lenders, according to people familiar with the matter.

Tuesday, March 6, 2018

Lego Decline Is Not a Trend

Sales fell at Lego, but it is not a trend. Lego was limited by excess inventories at the same time that Toys ‘R’ Us was careening into bankruptcy in two countries. Demand for Lego now follows a movie-release cycle, and the next Lego movie is still a year or more away. Over the next few years Lego will continue to benefit from the urge to build things that are material and three-dimensional to balance out a consumer experience that is increasingly digital.

Tuesday, February 27, 2018

Liquidation Expected at Toys ‘R’ Us U.K.

Media reports suggest that the Toys ‘R’ Us U.K. subsidiary is likely to go into administration very soon, either today or tomorrow. Despite reaching an agreement with creditors in December to allow it to stay open, the insolvent toy giant has failed to find a buyer. It no longer has any support from its bankrupt U.S. parent company. It has no funds to pay a delinquent tax bill with an effective deadline of March 1. The retailer is currently conducting store-closing sales in a fraction of its stores. With no source of cash, administration is its only option.

The likely outcome of administration is that all Toys ‘R’ Us stores in the U.K. will close by June. All inventory will be sold off, most of it to the public at going-out-of-business sales. Shelves at Toys ‘R’ Us stores in the U.K. are said to be as bare as those I have seen in the U.S., so there is not a mountain of toys to liquidate. Proceeds from the liquidation will pay the tax bill in full, but there will be little left over for pension funds, bondholders, and other creditors. Some 3,000 jobs will be lost.

The prospect of liquidation of the U.K. subsidiary casts more doubt on the parent company which operates Toys ‘R’ Us and Kids ‘R’ Us stores in the U.S. The U.S. company is in the process of closing 20 percent of its stores in bankruptcy, similar to the U.K. store closings. It faces most of the same challenges seen in the U.K. It has given no hint of a business plan that would allow it to emerge from bankruptcy, and time will run out on that process in a matter of weeks, so that a liquidation appears increasingly likely for Toys ‘R’ Us in the U.S.

Friday, February 16, 2018

Bankruptcy Watch for Barnes & Noble

Barnes & Noble is well on its way to closing. I expect that it will go into bankruptcy within a year and that all stores will close.

I come to this unhappy conclusion after looking at the news from Barnes & Noble’s disastrous December and the subsequent layoffs.

I have to start with the layoffs, because it seems the layoffs were twice as extensive as we initially heard. For an inside perspective see The entirely unnecessary demise of Barnes & Noble at Brain Fuzzies, and I have been able to corroborate many of the important details from other reports and my own indirect contacts among (former) Barnes & Noble staff. The number of job cuts was not around 1,000, as it first appeared, but perhaps more than 2,000. Initial news reports said that head cashiers and digital leads were laid off in many stores. Instead, all full-time in-store staff were fired, and it appears the stores from now on will be operated by minimum-wage workers who work no more than 25 hours a week. Certainly the store will still be mostly staffed by book enthusiasts, but you will no longer find anyone in the store for whom books are a career. The few remaining workers probably won’t have time to talk to customers anyway, but if they do have time, they won’t have the in-depth knowledge that might help you find the book you are looking for. With the professional staff gone, buying a book at Barnes & Noble will be almost like buying one at Target: you find the book on the best-seller rack and take it to the cash register. Obviously, there will be more books in the store than 100 best-sellers, but with the job cuts, the retailer is conceding it has little hope of selling them.

If you are a loyal Barnes & Noble customer, you need only imagine your local store staffed by just three workers to realize that the store you loved is already gone.

So the job cuts are pretty drastic and the impact on the customer experience is devastating. It is also a concern that the retailer allowed such misleading press reports about the job cuts. A company can’t expect to keep public-facing changes a secret. Large companies attempt this kind of deception only when things are pretty desperate.

The job cuts are a desperate move in themselves. The cuts are, it seems to me, something the company would only do if there was substantial doubt that they could limp along until the next Christmas season. Barnes & Noble, you must understand, is a company that is profitable only in the month of November during the peak of Christmas shopping. For all other months of the year the company takes a loss. The company’s whole cash-flow strategy, then, has to be all about getting to November. They wouldn’t throw away their future the way they just did by firing their entire staff of book professionals if they thought they could get to November any other way. My hunch, though, is that with the cuts, they feel reasonably confident in making it to November.

Perhaps that depends on some optimistic assumptions, but beyond that, the problem is that just getting to November isn’t a strategy. With the qualified sales staff gone, November 2018 in-store sales can’t possibly resemble those of November 2017. When Home Depot tried a similar strategy many years ago, revenue went down by about a quarter and that retailer barely survived. Barnes & Noble was barely getting by as it was. Imagine its revenue going down by a quarter. Yet there is no avoiding it.

This can only mean bankruptcy for Barnes & Noble, either going into the 2018 Christmas shopping season or, more likely, immediately after. A retailer that faced a crisis when revenue fell 6 percent (comparing December 2017 to December 2016) won’t be able to keep the lights on when revenue falls by a larger amount.

Once in bankruptcy, Barnes & Noble is assured of the same outcome that Borders saw eight years earlier. A rule of thumb is that a retailer can expect to emerge from bankruptcy if its core problems are debt and rent. Barnes & Noble’s worries cut deeper than that. Its entire business model is flawed, often in glaring ways.

As a measure of the operational problems at Barnes & Noble, I must mention the recent high-profile “relaunch” of Barnes & Noble’s digital book publishing platform. Although I have published e-books myself, I have never released one on Barnes & Noble’s Nook platform because the old Nook publishing site made the process virtually impossible. Despite a rebranding, a site redesign, and some technical improvements, when I went to look at the new site it appeared that all the vexing technical hurdles remain. If you have a novel with no typography more advanced than italic text, you can convert the novel to a word processing document and you can publish it on the Nook platform. If a book is anything more complicated than that, you likely won’t be able to get it to display correctly on the Nook via Barnes & Noble’s publishing platform. You may try for several days, as I did, before ultimately giving up. This is so even though the Nook from the beginning has been capable of displaying advanced ebook typography and layout. It is the publishing platform, not the device, that presents the obstacle. To undertake a “relaunch” without addressing any of the real problems looks to me like the same kind of misdirection as the misleading reports about the layoffs. That is, Barnes & Noble is trying to deliver a growth story even as it slowly shuts down.

A company is never more intent on a growth story than when it is hoping to line up financing for its bankruptcy reorganization. Borders did vaguely similar things. But the prospects of a book retailer emerging from bankruptcy are a lot dimmer now than they were when Borders went into liquidation. If Borders could not keep any stores open in 2011, there is nothing to suggest that a bookseller will be able to borrow money in bankruptcy to keep stores open in 2018 or 2019. If the far-fetched scenario of bankruptcy reorganization is what Barnes & Noble’s planning is pointing toward, that means that the company does not see any preferable scenario that has any reasonable chance of occurring.

There are other signs of financial desperation at Barnes & Noble. One recent development is a determined push to reduce inventory. The retailer is shipping books from store shelves to online buyers. It is a relatively quiet, if highly inefficient, way to get more stock out of the stores before it is too late.

So Barnes & Noble gives every indication of going into bankruptcy in a year or less, and the likely outcome is that all stores will close. The aftermath represents a problem for the book industry, as the Barnes & Noble chain represents about half of the remaining bookstores in the United States. My own county, population half a million people, will be left without a traditional bookstore, that is, one that sells popular new books. It will be harder to sell books, and book publishers will have to cut back accordingly. I have to imagine publishers are already drawing up lists of scheduled 2019 book releases that they may have to cancel. Worse, Barnes & Noble operates a significant fraction of college bookstores, it seems like about half but it is probably not as many as that, and I would imagine that those stores too could close in a bankruptcy liquidation. It will be up to each college to find a way to reopen its bookstore, and if the fall 2019 academic season depends on it, it is not too soon for colleges to start to think about what they will have to do.

Then there is the question about what will happen to the Nook e-readers. Nook unit sales have showed rapid decline in the last two years. The Nook devices are essentially orphaned now that Barnes & Noble has fired all its digital leads, the in-store staff who understood in detail how the Nook works. I don’t know the Nook platform well enough to hazard a guess as to which Nook models will continue to work in some fashion after Barnes & Noble goes dark and which will not work at all. I will just say that if a bankruptcy is announced, Nook users should immediately look into the question of how to save their important e-book purchases, because doing so might not be a simple process.

I cannot close without mentioning a story about Barnes & Noble’s local history. The first Barnes & Noble store in my area was on the site of the Valley Forge Music Fair, a concert venue that was harassed into closing by the local government for reasons that were never revealed to the public. It was a very popular place to see music, and as it was demolished, I wondered if the ill will surrounding the forced closing would adhere to the retail stores that took its place. Perhaps to guard against this possibility, the developer did not place a store on the site of the actual venue. Instead the new stores were in the places formerly occupied by the parking lot, with the new parking lot occupying the place where the stage and audience used to be.

Despite this precaution, the stores have not fared well. Linens-N-Things, the largest store, lasted only a few years, and the pet store that took over its spot does not seem to be doing much better. Now my guess is that Barnes & Noble, the second store, will also be closing. It is one of many stories that tell you that tearing down something old to build something new does not carry the promise that the new thing will succeed.

Wednesday, January 31, 2018

Hawaii Missile Alert Shows Lack of Civil Will

The false missile alert in Hawaii, we have learned, was the result of a rogue drill. The drill was meant to test the ability of civil defense officials to respond to an alert, but workers and a supervisor weren’t properly prepared for the drill, and the wording of the alert in the drill incorrectly contained a statement saying it was not a drill. Hawaii has temporarily suspended all such drills. Knowing that there was never any true information indicating a danger lightens the situation somewhat but is not as reassuring as it might be.

The problem of the rogue drill was compounded by at least five other problems. There are weaknesses in the user interface of the software used by state civil defense workers to send alerts. The state had no plan in place to retract an incorrect alert, and that was the main reason it took most of an hour to issue a retraction. The Pentagon and White House also obviously did not have a plan to react to this scenario. The governor was unable to respond quickly because he had lost his Twitter password.

The whole situation points to a lack of civil will. The officials charged with a response in this specific situation were not particularly interested in forging an effective response while the masses who did respond to the alert were prevented from getting any meaningful information on the events that were taking place. Secrecy and opacity worked against the government in this episode. An institution created for the purpose of a coherent collective response to a crisis instead became an obstacle that prevented any meaningful response.

There were plenty of people, more than a million paying close attention in Hawaii and beyond, who could have helped sort things out if they had not been kept completely in the dark. More than a dozen crises of 2017 showed how well Americans self-organize when the situation calls for it. In the false Hawaii missile alert, the government was the obstacle that prevented that from happening.

Tuesday, January 30, 2018

After Weak Sales, Future in Doubt at Toys ‘R’ Us

A source connected to Toys ‘R’ Us told a reporter at CNBC that holiday season sales at the bankrupt toy giant were so poor that its bankruptcy financing is being called into question.

We already knew that stock, traffic, and revenue were down during the holiday shopping season at Toys ‘R’ Us, but prices too were lower than planned as the retailer “discounted roughly 10 percent more of its products in holiday 2017 compared with the prior year.”

Deeper in the story is the hint that the two largest toy manufacturers, Mattel and Hasbro, might not support an exit from bankruptcy for Toys ‘R’ Us. These two manufacturers supply most of the products sold in Toys ‘R’ Us despite having a smaller market share in every other distribution channel, so they would lose a significant amount of market presence if Toys ‘R’ Us were to close. Analysts had previously assumed these two manufacturers would support Toys ‘R’ Us no matter what happened, but with the whole toy industry in decline, toy manufacturers are not financially strong enough to prop up a perpetually struggling retailer. The planned liquidation of 20 percent of Toys ‘R’ Us U.S. stores and dozens more at the U.K. subsidiary already put unusual financial pressure on the toy manufacturers.

Targeting Health Care Paperwork

The headline that shook the health insurance sector this morning: “Amazon, Berkshire Hathaway, and JPMorgan Chase to partner on US employee health care.”

While details are few, this is the largest new initiative in U.S. health care in several years. The three employers have 1 million employees, so the new company could, at launch, control 1 percent of the U.S. health care market. The paperwork burden will be the initial focus:

"The healthcare system is complex, and we enter into this challenge open-eyed about the degree of difficulty," said Amazon CEO Jeff Bezos. "Hard as it might be, reducing healthcare's burden on the economy while improving outcomes for employees and their families would be worth the effort."

"Our people want transparency, knowledge and control when it comes to managing their healthcare," said JPMorgan Chase CEO Jamie Dimon. "The three of our companies have extraordinary resources, and our goal is to create solutions that benefit our U.S. employees, their families and, potentially, all Americans."

The new company's goal at first will be to target technology solutions to simplify the health-care system.

Any technology-focused effort could surely find a way to streamline the administrative burden of health care. In its current form, health care data flow is a hodgepodge of papers, fax machines, web portals, spreadsheets, data warehouses, and password-protected files attached to email messages. The office buildings where health coverage decisions are made are larger than hospitals. Data leaks are so common that most Americans have had parts of their health history exposed. Insurers so routinely decline coverage for needed medical treatments that health care costs are the leading cause of bankruptcy among those with or without health coverage, and the potential inability to get medical treatment is one of the all-pervasive anxieties in American life. The bar is set so low, any company determined to take a fresh look at the problem could easily do better.

Though the initial focus on paperwork points to the greatest potential for efficiencies that could put new pressure on health care companies, the sector is equally worried about another detail: the new joint venture will not be expected to make a profit. This is why CVS and several other health care stocks are down 6 percent this morning. It is hard for a profit-making company to compete with one that is just trying to solve a problem.

Wednesday, January 24, 2018

Toys ‘R’ Us Closes 20% of Stores

While we wait for a restructuring plan from Toys ‘R’ Us, the clock is ticking, and the bankrupt retailer had to make some quick decisions about store closings. The store closing plan (PDF) filed last night in bankruptcy court and pending court approval, would close about 180 Toys ‘R’ Us and Babies ‘R’ Us locations, about 20 percent of stores. The store closing list (PDF pages 72-74, 82) includes many locations where the two stores are located together. In total, 79 Toys ‘R’ Us stores, 126 Babies ‘R’ Us stores, and one outlet store will close.

The affected stores are expected to completely liquidate between early February and early April. I have seen photos from December of nearly bare shelves in Toys ‘R’ Us stores, so there will not be as much stock to liquidate as you would normally expect to see in a store closing. It will not be a surprise if workers move the remaining toys to a small area at the front of the store to make it easier for shoppers to find the merchandise.

Deciding what stores to close is not the same as writing a restructuring plan, and only the legal deadlines provide assurance that such a plan is on the way. The store closing plan and the simultaneous letter to loyal customers point to the principles in play as the company tries to forge a plan, but these early documents provide little insight into the practical steps that must follow. Toys ‘R’ Us went into bankruptcy without a plan and then suffered a disastrous December in stores. It is suffering not just from a high debt load and its own missteps, but also from larger trends unfavorable to toys, children’s books, and movie tie-ins. These headwinds make it unlikely that a toy retailer can increase revenue no matter how well-managed it is.

There is little margin for error, then, as Toys ‘R’ Us writes its plan, yet everything we have seen so far has the air of procrastination and resistance – errors that would tend to leave a struggling company too large and too fragile to survive after its restructuring. It is hard for me to imagine how Toys ‘R’ Us can rebuild its customer experience as it says it must while operating for the next five years or longer at a loss.

But those details will follow. For now, closing 20 percent of stores is a step forward that, as the company put it in its letter to customers, gives it a better chance of carrying on.

Toys ‘R’ Us stores closing
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Babies ‘R’ Us stores closing
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Toys ‘R’ Us outlet store closing
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